PE in Asia lags in operational value creation, says survey

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As Asia's free-market economies mature, general partners (GPs) need to change the way they work with their portfolio companies, according to a survey by AlixPartners.

The report, entitled "Building Better Businesses; A Survey Report on Private Equity Value Creation in Asia," says that doing more hands-on work to increase portfolio companies' operational earnings, as measured by EBITDA, is potentially becoming a key differentiator.

Market forces in Asia, such as slowing economic growth and industry consolidation, were ranked first by GPs as the main reason operational value creation has come to the forefront, followed closely by poor operational management currently at portfolio companies, difficulties private equity has been encountering in exiting deals and the desire of private-equity firms to build a reputation for their own long-term development.

Although pressure from limited partners (LPs), the investors in private-equity funds, was ranked last by respondents as a driver for operational change, its importance should not be underestimated, according to the study. GPs surveyed said that LPs are increasingly equating operational expertise with the ability to deliver sustainable returns. In fact, 84 per cent of GPs said the ability to demonstrate previous operational experience to LPs is essential or important to fund-raising.

In many parts of Asia, companies in industries that grew for years on the back of strong domestic growth may now have to look hard at optimizing business strategies, according to the study. Additionally, it notes that public markets in much of the region have been challenged, which has not only limited exits via initial public offerings but has also tended to lower the value of mark-to-market assets held by private equity.

The study finds that this appears to be especially true for companies in the manufacturing sector, with both consumer products (cited by 54 per cent of respondents) and industrial products (cited by 50 per cent) seen as the sectors requiring an operational focus the most, as well as the retail industry (cited by 50 per cent of respondents).

In comparison with their counterparts in the West, private equity firms in Asia are behind when it comes to value creation at their portfolio companies, according to 66 per cent of respondents. This, says the study, is likely due to Asia's patchwork of cultures, languages, infrastructure and regulations, which create very unique challenges for private-equity firms carrying out operational work in the region.

According to AlixPartners' survey, GPs ranked finding talented operation experts first as their biggest challenge in creating operational value today in Asia, followed closely by the cost and time involved with operational matters. The study notes that many parts of Asia appear to have a shortage of experienced operational professionals, likely due to the relatively short history of a private sector in some countries, and to state-owned or -controlled sectors in others.

Additionally, the study points out that implementation of operational value-creation strategies is particularly challenging in Asia. According to 86 per cent of GPs, the reason for this is that minority ownership stakes, which are common in Asia, tend to limit the ability of a private-equity firm to drive true operational change. As a result, says the study, GPs need to build a close working relationship with players such as the company founder and existing top management; in fact, the majority of GPs surveyed (61 per cent) cite this strategy as the most effective way of carrying out operational improvements at such portfolio companies.

Turning to countries, China was cited as the most challenging Asian country for accomplishing operational improvements, according to 53 per cent of survey respondents who were required to rank the top five Asian countries, followed closely by India (cited by 45 per cent) and countries in Southeast Asia.

Respondents indicated that until now, few private equity deals in China have been total buyouts, in keeping with the historical trend cited above. However, the study also notes that could change, as many company founders are now nearing retirement age and that many second-generation family members may not want to take over the family business. Therefore, says the study, managements are likely becoming more open to professional operations assistance, which, in turn, can also help provide an exit for the founder.

The study notes that India, unlike China, is a patchwork of semi-independent states and that culture, language and regulations can differ significantly in different parts of the country, which can present big hurdles for implementing operational change, not to mention scaling businesses, up or down.
Additionally, the Southeast Asia countries of Indonesia (selected by 32 per cent of respondents), Vietnam (29 per cent), Cambodia (29 per cent), the Philippines (24 per cent) and Laos (22 per cent) were ranked in the middle in terms of the challenges of implementing operational changes, likely due, says the study, to a lack of trained management and employees, high employee turnover and funding inadequacies.

Despite all the challenges in Asia, the study says the payoff of operational value-creation work is demonstrable and repeatable, and for GPs who have raised at least two funds, 94 per cent say operational work has increased their portfolio company's value. In the past, operational improvements have mainly been generated by improving financial management according to 71 per cent of respondents. Closely behind is cost-base management, cited by 67 per cent of respondents. Respondents also cited improvements in the sales force (selected by 62 per cent), the product and/or service quality (selected by 50 per cent) and the supply chain (selected by 47 per cent) which, says the study, supports the idea that industries in Asia Pacific can be made much more efficient.

The survey also finds that 64 per cent of GPs say they do not have metrics in place that allow them to confidently measure success of their operational-improvement programmes, despite 58 per cent of respondents describing their programs as "mature." This contradiction, says the study, suggests that the definition of operational value creation is highly subjective and that therefore key performance indicators (KPIs) differ widely.

Masahiko Fukasawa, managing director and co-head of Asia, says: "Private equity in Asia is entering a new phase in which creating value will need to be through operational excellence, which in turn, will build more competitive businesses. A crop of private equity firms is increasingly doing larger deals and coming across more buyout opportunities than a few years ago. These more-complex deals require greater operational expertise, which is challenging for private-equity firms to develop on their own."